valuation of non-market goods lecture 5. outline 1.project evaluation 2.the need for values of...
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Valuation of Non-Market Goods
Lecture 5
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Outline
1. Project Evaluation2. The Need for Values of Non-Market Goods
• Cost benefit analysis• Concepts of economic value
3. Valuation Technique: Contingent Valuation• Survey evidence
4. Valuation Technique: Inference from Market Behaviour• Travel Costs method• Avertive behavior• Hedonic Pricing
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Valuation of a Private Project
Step 1: Evaluate Monetary Costs and Benefits
Year Benefits Costs Net Revenue0 B0 C0 R0 = B0 -
C0
1 B1 C1 R1 = B1 - C1
2 B2 C2 R2 = B2 - C2
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Step 2: Add them up!
R0 + R1 + R2 + R3 + ?????????????????????
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Step 2: Add them up!You have to remember that money tomorrow is
worth less than money today.If I invest £100 today I get back £100 x (1.02) =
£102 next year if the interest rate is 2%.Thus £102 in a year’s time is worth £102/1.02 =
£100 today
Similarly, £ R1 in a year’s time is worth
£ R1 / (1+interest rate) today.
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Present Discounted Value
PDV = R0 + R1 + R2 + R3 +
(1+r)1 (1+r)2
(1+r)3
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Decision Rule
Undertake the project if
PDV >0
Or NPV>0
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Basically need to do the same thing for Public Projects but…
1. Many more costs and benefits – need to find them all not just how they affect a company.
2. Its hard to evaluated costs and benefits. Often cannot use prices.
Need to find ways of valuing these things.
Decision rule is again undertake project if PDV >0!!
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Example
Building a RoadCosts: Materials 100m in first year.Labour 15m in first year.Maintenance 10m per year.
At a 5% social discount rate 10m per year is(1.05/.05)*10m = 210m
Total Discounted costs = 325m = 210+100+15
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Building a Road
Benefits Driving time saved: 500,000 hours per year.Lives Saved: 5 lives per year.
Suppose we assess this as being worth y per year. Then the road should go ahead if
y*(1.05)/.05>325m!
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Cost Benefit AnalysisThis is the name for evaluation techniques for
public projects.
Examples of non-market price problems:1. Improved public health?
Costs are well knowBenefits (longer lives & better health)
2. Improved Environmental Quality.Costs ?Benefits?
Cannot just ignore things you cannot measure.
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Where do the Costs and Benefits come from?
Personal Use Values1. Direct Use (Consumption of outputs)2. Indirect Use ( Functional benefits) Flood control,
climate etc.3. Option values (Future direct and indirect use)
Non-Use Values1. Bequest Values: Value of passing assets on2. Existence Value: Knowledge of continued
existence.
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Contingent ValuationDirect survey evidence on individual’s stated
valuations.
How much an individual would be willing to give up to have the specified improvement?
Notes:1. Similar tools used for market research, but market
research can be checked against future behaviour.2. Evidence of use and non-use values.3. Controversial in US as it was used in Exxon Valdez
suit.4. NOAA panel has issued guidelines on its use.
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Contingent Valuation Formats
Willingness to pay vs. Willingness to Accept.
WTP – What is the most you are willing to pay for 5 days without air pollution?
WTA – How much would compensate you for ….?
In theory they should be close to equal if they were small amounts.
WTA>>>>WTP in practice.WTP seen as more reliable, less prone to protest.
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Contingent Valuation Formats
Open Ended vs. Closed Ended Questions .
Open ended: What is the most you would be willing to pay for…?
Popular early on and can be easily analysed.
Closed ended: If it cost $20 would you be willing to pay this?
Respondents find these q’s easier to answer.But requires more complex analysis.
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Problems in CV studies1. Treatment of Outliers – a source of bias
• Strategic responses• Protest answers (refusal to answer)
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Problems in CV studies1. Treatment of Outliers – a source of bias
• Strategic responses• Protest answers (refusal to answer)
2. Embedding Problem• Tendency for WTP answers to be similar
across different surveys.• Part-whole bias – some people claim this
invalidates the whole process
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Problems in CV studies1. Treatment of Outliers – a source of bias
• Strategic responses• Protest answers (refusal to answer)
2. Embedding Problem• Tendency for WTP answers to be similar across
different surveys.• Part/whole bias – some people claim this invalidates
the whole process3. Starting Point Bias
• Structure of survey influences all responses and the order of magnitudes in responses.
• Yes/No Q’s in ascending vs. descending order influences answers given.
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Problems in CV studies1. Treatment of Outliers – a source of bias
• Strategic responses• Protest answers (refusal to answer)
2. Embedding Problem• Tendency for WTP answers to be similar across
different surveys.• Part whole bias – some people claim this invalidates
the whole process3. Starting Point Bias
• Structure of survey influences all responses and the order of magnitudes in responses.
• Yes/No Q’s in ascending vs descending order influences answers given.
4. Instrument Bias• Proposed financing affects peoples’ answers.
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NOAA Panel on CV
Recommendations:1. Sample: Statistician recommend size and type to ensure
significance of results.2. Non-responses High rate makes results unreliable.3. Interviews Face to face are best, must test effect of
interviewer.4. Reporting Data and procedure used must be available to
all.5. Questionnaire design: Piloted + pre-tested 6. Cross-tabulations: Cross checks to assess interpretation of
data7. Elicitation procedure: WTP better than WTA, Yes/No Q’s8. Accurate Description of issue9. Expenditure implications
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Inference From Market Behaviour1. Travel Costs:
How much does it cost to travel to Alaska – how many people do it.This gives a lower bound
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Inference From Market Behaviour1. Travel Costs:
How much does it cost to travel to Alaska – how many people do it.This gives a lower bound.
2. Avertive Behaviour:What costs to people incur to avoid certain risks.This gives an upper bound.
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Inference From Market Behaviour1. Travel Costs:
How much does it cost to travel to Alaska – how many people do it.This gives a lower bound
2. Avertive Behaviour:What costs to people incur to avoid certain risks.This gives an upper bound.
3. Hedonic Pricing:Use differences in market prices to impute a value for a hidden variable. (Shadow Pricing)Parking near a ball ground.House prices
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Values for Life and Time
Time:Opportunity Cost – if you gave up work then it is your wage.If you gave up leisure – how much would you pay to travel quicker?
Life & Mortality:Implicitly this values health too.
QALY = Quality-Adjusted Life YearsThis is a standard accepted measure.You can use CV evidence to assess this –
life insurance contracts etc.
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Examples of Implicit Values of Life
Legislation imposes costs and achieves a reduction in lives lost. You can deduce a value of life from these costs:
Legislation Implied 2005($) value of Life
Childproof Lighters 0.1mFood labeling 0.4mReflective devices for Lorries 1mRear seatbelts 4.8mAsbestos 6mGov Value 7.6mCattle feed reg’s 185m
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Time and Risk
How should we assess future costs and benefits?• This really has a huge affect on very long-lived
projects.• Could look at market rates or how individuals
make these trade offs, but generally they vary with the population’s characteristics.
• Maybe we should explicitly include future generations welfare in the benefits side?
• How rich should we assume they are going to be?• Should we give them equal weight or less weight?
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Risk?
Most common route is to discount at a higher rate,???
Risk premium?
Worst Case Scenario?
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Distributional issues